Real Effective Exchange Rate Dynamics in Transition Economies: Evidence of Nonlinear, Asymmetric, and Threshold-Based Adjustment

Abstract

This study re-examines the validity of purchasing power parity (PPP) in transition economies by investigating the dynamics of real effective exchange rates (REERs) for nine countries over the period 1994-2024. Given the profound economic transformation, policy regime changes, and recurrent external shocks experienced by these economies, the analysis employs a unified empirical framework combining linear unit root tests with nonlinear, asymmetric, threshold autoregressive (TAR), and Zivot-Andrews unit root tests with an endogenous structural break. The empirical results reveal substantial cross-country heterogeneity and provide only limited support for PPP as a general long-run equilibrium condition. Nonlinear or regime-dependent mean reversion is identified for only a subset of countries, while REER deviations remain highly persistent in most cases, even after accounting for asymmetries and structural breaks. The TAR findings are broadly robust to alternative threshold definitions based on the 25th, 50th, and 75th percentiles of the threshold variable. These findings contribute to the literature by providing a comprehensive assessment of linear and nonlinear REER adjustment dynamics within a unified empirical framework. The evidence suggests that PPP-based mean reversion cannot be regarded as a general characteristic of real exchange rate behaviour across transition economies and highlights the importance of considering nonlinear, asymmetric, and regime-dependent adjustment mechanisms when evaluating long-run exchange rate dynamics.